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Until September 2007 Superannuation Funds were prevented from borrowing. However, in September 2007, legislation was passed by the Senate to allow borrowing by Superannuation Funds; these new rules are contained within section 67(4A) of the SIS Act.
The relevant subsection is headed “Exceptions – instalment warrants” and is not limited to traditional warrants but authorises any borrowings made by a Superannuation Fund provided that:
- the borrowed money is applied for the purposes of acquiring an asset other than one which the Fund is prohibited from acquiring;
- the asset is held on trust so that the Fund acquires the beneficial interest in the asset;
- the Fund has a right to acquire legal ownership of the asset; and
- the rights of the lender against the Superannuation Fund for default on the borrowing, or on the sum of the borrowing and charges related to the borrowing, are limited to rights relating to the asset.
Effectively this means that any borrowing arrangement that is allowed under section 67(4A) of the SIS Act must be done so on a limited recourse basis. Consequently the existing assets of the Fund may not be used as security regardless of the performance of the new investment.
How the legislation affects you
The new legislation means that you can structure borrowing through your Superannuation Fund so as to allow the Fund to acquire any asset that is permitted under the SIS Act.
If properly structured through an Instalment Warrant, a Fund can borrow to acquire an asset. Examples of where a Fund might seek to borrow are:
- to allow the Fund to acquire an investment property;
- to allow the Fund to acquire a share portfolio;
- to acquire units in a unit trust (for example a small group of persons might want to set up their own unit trust to acquire a substantial investment property).
Prohibited Assets
The reference to assets which the Fund is prohibited from acquiring is a reference to section 66 of the SIS Act, which prohibits the Trustee or an investment manager of a regulated Superannuation Fund from intentionally acquiring an asset from a Member or from an associate of a Member, unless that asset is an ‘excepted asset’; i.e. business property and listed securities. Acquisitions must also be made at the present market value.
Beneficial Ownership
The Fund is not allowed to be the legal owner of the investment, however it must be the beneficial owner of the asset. For that reason an entity must hold the asset on trust for the Fund, such as a separate Trustee Company (i.e. not the Corporate Trustee of the Fund).
Furthermore the trust must not be an “active trust” as there may be adverse capital gains tax consequences if the Fund calls for transfer of the legal title. The entity holding the asset will hold it as a Bare Nominee as a result, the asset must be managed by the Fund, for example if the asset is real estate the Fund must collect rent and attend to repairs.
Funding
The essence of the legislation is not directed to warrants but rather to allow Funds to make limited recourse borrowings.
There is no requirement as to whom the lender might be but the most obvious arrangement is for a bank to lend directly to a Fund; some banks have been slow to recognise this new legislation. An alternative is for a Member to borrow from a bank and lend those borrowed monies to the Fund (or for the Member to lend to the Fund their own capital, which may also be used as an asset protection device).
As security, the Fund can only provide the asset itself and income generated from the asset. In some circumstances the Member may also be required to provide the lender with additional security as collateral over the borrowing.
Trustees of the Instalment Warrant
The Security Trustee should not be the Fund Trustee. It would be preferable if a Corporate Trustee Company was established, due to the legal protections and limited liability structure this provides. However, the Members can be Instalment Warrant Trustees providing they are not the Trustees of the Fund.
Capital Gains Tax
The Trustee must be a ‘Bare Trustee’ in order to avoid capital gains tax and stamp duties on transfer of an asset from a Trustee. If the assets comprise of shares, the Trustee consequently does not have any positive duties. A manager must be appointed to manage the asset if it comprises of real estate.
Negative Gearing Advantages
It is quite likely that any rent received by the Fund (when the underlying asset is real estate) will be insufficient to meet interest expenses incurred by the Fund. Any shortfall may be met by tax deductible contributions made to the Fund.
By making tax deductible contributions, the Member will effectively receive a negative gearing advantage. This advantage sought by Members from borrowing could place the investment in a tax effective structure.
Requirements & Considerations
- A Self Managed Superannuation Fund (Fund).The Fund needs to possess the power to acquire an investment warrant (including borrowing provisions).
- The investment strategy of the Fund needs to accommodate the acquisition of a warrant; an amendment to the Fund’s Investment Strategy is included in this package.
- A Security Trustee, which will acquire the asset and hold the legal title of the asset on trust for the Fund.
The Security Trustee cannot be the Trustee of the Fund. The Security Trustee may be an Individual or Individuals; however a Corporate entity is preferable given the legal protection it provides.
The Security Trustee must be a “Bare Nominee” for the purposes of Capital Gains Tax, as discussed in this guide.
- The Fund is responsible for managing the asset; for example, if the asset is real estate then the Fund must collect the rent and manage all repairs.
- Capital raised by the Fund, to allow the Security Trustee to pay the vendor for the asset being acquired.
In order for the Security Trustee to take effect, the Fund must utilise the Funds borrowed to acquire the asset; Funds may be borrowed from a financial institution or an Individual. This package contains a loan agreement applicable for an Individual issuer of finance. A financial institution may, however, require the Security Trustee to provide a mortgage on any acquisition of property.
- An Instalment Warrant Deed executed by the Security Trustee and the Trustee of the Fund; a Warrant Certificate and an Instalment Warrant Deed is included in this package.
- An investment, which is to be acquired by the Security Trustee as a Bare Nominee for the Fund.
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